Can Cablevision 'Close the Gap'?

8/01/2008 8:00 PM Eastern

By: Mike Farrell

Cablevision Systems investors may be having déjà vu with the Dolans.

Less than one year after its third attempt to go private was rebuffed by shareholders, Cablevision Systems, fueled by yet another strong operational quarter, has vowed to “close the gap” between public and private valuations of the company, stating it will actively pursue alternatives to boost value.

While Cablevision's options could include spinning off assets, buying back shares, issuing a dividend, or possibly taking the company private, some analysts believe that Cablevision will ultimately spin off its Rainbow Media programming unit — which includes IFC, WE TV, AMC and the Sundance Channel — into a separate publicly traded company. A possible privatization of the cable company could come as much as 18 months later.

“The first step may be to split up content and cable first,” said Collins Stewart media analyst Tom Eagan. “A cable privatization could be a year and a half away.”

The Dolan family's last attempt — its third — to take the company private last year for $36.26 per share ($10.6 billion) was rejected by shareholders at a special meeting at company headquarters in October. Since that offer was rebuffed, Cablevision shares have plunged along with the rest of the cable sector amid fears of growing competition from telcos and the general economic malaise.

But Cablevision, more than any other cable company, has shown surprising strength, beating analysts' estimates consistently and proving its mettle in the face of the greatest exposure to the most aggressive telco in the video and high-speed data space, Verizon Communications.

Verizon's FiOS TV product is available in nearly one-third of Cablevision's footprint and yet the cable company has managed to consistently outperform its peers. Cablevision has the highest digital video penetration (89.1%) in the country, the highest cable-telephony penetration (37.6%) and the greatest high-speed Internet penetration (51%).

And yet that performance has not translated to the stock, which before July 31 was down about 12%. It was that frustration with the markets that appears to have prompted Cablevision CEO James Dolan to pledge during its second quarter conference call with analysts July 31 to actively explore ways to align the public valuation of the company with its private valuation.

“We have a strong desire to close the value gap between our operating performance and the market value of our stock,” Dolan said on the call. “We recognize that current capital-market conditions may contribute significantly to this value gap and we are considering and actively exploring alternatives that may close this gap and want to assure our investors that we will be open to listening to their thoughts. In this regard, the company and I personally plan to spend more time communicating our compelling story to our investors and listening to their thoughts on our performance and prospects.”

That statement was a big departure from the company's stance after its last going-private attempt was rebuffed. After that rejection, the Dolans seemed to turn “almost hostile” toward investors, according to Pali Research media analyst Rich Greenfield, declining to participate in industry conferences and investor meetings and no longer issuing financial guidance.

“Now in a dramatic shift, the Dolans appear to care about investors again,” Greenfield wrote.

The motivation for that change of heart could be quite simple — much of the Dolan family's personal wealth is tied to Cablevision stock.

In a research note, JP Morgan analyst Bryan Goldberg wrote that personal wealth creation, creating an acquisition currency and winning over investors who rejected the old going private offer so a new privatization deal could be launched could be the Dolans' motivation. “Too soon to tell, but the odds of a share buyback and/or dividend have increased,” Goldberg wrote, adding Cablevision likely wouldn't do anything drastic until 2009.

Whatever the motivation, Dolan's pledge had an immediate effect on the stock. Shares of the Bethpage, N.Y.-based MSO rose as high as $25 per share on July 31 (up 17.6% or $3.75 each), before settling back slightly to close at $24.28 per share, up $3.03 each, or 14.26%. Essentially in one day, Cablevision erased a year's worth of declines for its stock.

But it still is a far cry from what some believe the company is worth. Last year, during the battle to take Cablevision private, Gamco Investors chairman Mario Gabelli argued that Cablevision was worth more than $50 per share (a value that he still believes holds true), substantially higher than the $36-per-share offer from the Dolan family. And earlier this year, Sanford Bernstein cable and satellite analyst Craig Moffett issued a report that made a case for Cablevision being worth as much as $100 per share in four years.

Whether those values can be achieved remains to be seen. But some analysts believe that the company is ripe for a new issue — splitting off the Rainbow unit.

Cablevision has tried to spin off Rainbow in the past — it was a tracking stock in the earlier part of the decade, only to be re-absorbed into the company in 2002. And in 2005, as part of the Dolan family's first attempt to take the cable company private, the Dolans proposed spinning off Rainbow in a complicated deal that valued the unit at about $12.50 per share.

But today's Rainbow media is a different animal. Eagan said that with the ratings success of AMC shows like Mad Men and Breaking Bad, AMC has its biggest buzz in years. And the success of those shows and others has translated into strong results at Rainbow.

In the second quarter, revenue at the Rainbow division rose 14.6% to $239.7 million and adjusted operating cash flow increased 71.6% to $72.3 million. At AMC/IFC/WE, revenue was up 12% to $186.6 million and adjusted operating cash flow increased 22.4% to $90.8 million.

“The risk that they took with original programming at AMC was huge, and it worked out,” Eagan said.

While Eagan believes a Rainbow spinoff is practically inevitable, Moffett said that going private may not be off the table yet.

“Dolan's speech would seem to open the door to all options, including a one-time special dividend (like that paid in 2006), regular dividends, share repurchases, or even another attempt to take the company private,” Moffett wrote.

While Cablevision has several options, Dolan said on the call that no particular option stands out above others at the moment.

“There are some obvious potential moves the company could make,” Dolan said. “But we need to study them before we say much more about them. We want to tell our story and we want to listen to shareholders about what they think too.”

Dolan said there is no disconnect between the interests of the Dolan family— which owns the majority of voting shares of the company — and other shareholders. “I want to assure you and everyone else that the family's interests and the rest of shareholders' interests are completely aligned on this,” Dolan said.

Gabelli, whose funds hold about 20 million Cablevision shares, said Jim Dolan was “singing my song” but “the question is: will he execute on it?”